Why Barclays Is A Buy At 139p

Published in Company Comment on 23 September 2011

As shares plunge again, one Fool is itching to buy a bit of a bank.

Before the credit crunch shook world markets in August 2007, financial shares made up a large proportion of my portfolio.

However, from 2005 onwards, I repeatedly warned readers of a brewing 'financial hurricane', caused by unsustainable booms in house prices and reckless lending. As increasingly more signs of the coming hurricane emerged, such as the huge losses on US subprime mortgages racked up by HSBC (LSE: HSBA), I became increasingly anxious. 

By the end of 2007, I had liquidated pretty much my entire holding of financial firms. Out went HBOS and Lloyds TSB -- now combined as Lloyds Banking Group (LSE: LLOY) --  Royal Bank of Scotland (LSE: RBS), Legal & General (LSE: LGEN), Royal SunAlliance (LSE: RSA) and others. After this clear-out, I was left with no exposure to banks and insurers, but plenty of cash.

In hindsight, this sell-off proved to be one of the best financial decisions of my life. More by luck than judgement, I sold off these shares at close to peak prices. More importantly, I sold before some went on to record brutal losses of 95%+.

Biased against banks

Since my 2007 sell-off, I haven't bought even a single share in any bank -- not one in four years.

Frankly, the evidence of reckless behaviour which emerged between 2007 and 2009 put me right off buying bank shares. The £1.3 trillion banking bailout by taxpayers also coloured my judgement, too. Why take the risk of buying into businesses that were so obviously terribly run?

Today, I remain pessimistic about the UK housing market and expect further weakness in house prices. Likewise, I expect consumer and corporate demand for credit to remain weak until at least 2014. Neither trend will help bank profits to grow.

Big, big falls

However, the recent slump in bank shares prices has caught my eye, leaving me wondering if now is a good time to dip a toe back in the banking water.

Here's how the shares of major banks have performed in the last two months, before the latest round of financial turbulence began (ranked from highest to lowest falls):

BankPrice on
22 July
Price nowChange
Barclays (LSE: BARC)240p139p-42%
Royal Bank of Scotland37p22p-40%
Lloyds Banking Group47p33p-30%
HSBC612p494p-19%

Source: Yahoo Finance UK

I have excluded Standard Chartered (LSE: STAN) from my table, because it does little business here in the UK.

As you can see, mega-bank HSBC has been a relative safe haven. The two state-supported banks, Lloyds and RBS, are down significantly but Barclays, with its heavy exposure to investment banking via Barclays Capital, is down a whopping 42%. Barclays shares fell almost 10% yesterday, when the FTSE 100 fell 4.7%. Ouch.

Of the four banks listed above, HSBC is by far the safest and strongest, but is likely to be the most boring in terms of share-price escalation. 

Of the remaining three, I cannot bring myself to buy Lloyds (41% taxpayer-owned) and RBS (83% taxpayer-owned), as they don't pay dividends. Also, I fear that meddling politicians could interfere with these two banks anew.

Barclays' basics

Thus, I'm left with Barclays as the bank to run my rule over. Here are the latest forecasts for its fundamentals, based on yesterday's closing price of 139p:

Price-earnings ratio5.1
Dividend yield3.9%
Dividend cover4.3
Market value£17 billion

Source: Digital Look

If this were any company other than a bank, I'd seize on these fundamentals as a strong argument to buy its shares.

What's more, capitalised at a mere £17 billion, Barclays today is now a tiddler when compared with its global peers. Hence, it would be a cheap prize for a well-capitalised foreign bank to snap up. The way things are right now, 300p a share would probably tempt big shareholders to sell.

All things must pass

In short, barring another financial Apocalypse on par with the aftermath of the bankruptcy of Lehman Brothers in September 2008, Barclays looks like a (nervous) buy to me.

Sure, buying Barclays now may mean enduring months of roller-coaster turbulence as shares jump and slump in response to economic news from the UK, US and Europe. Even so, I reckon there is a big disconnect between Barclays' future prospects and its current share price.

Brave, bold buyers of Barclays today could well prove to be tomorrow's big winners!

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Comments

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SevenPillars 23 Sep 2011 , 12:45pm

The problem with the banking sector from an investment standpoint is that it is more prone to volatility based on macro economic/financial issues than arguably any other sector right now. Your analysis may well be right, but when HSBC is considered one of the most stable yet has fallen nearly 20% in the last 3 months, this shows that any purchase is still a gamble right now on there being less bad economic/financial news to come. Greece defaults and UK banks could easily drop another 30-90% depending on their exposure? There is still too much bad news around to trust any analysis of an individual bank share to be able to withstand the bigger picture.

Banks are more a traders sector right now, unless you are prepared to accept the volatility of big down swings when the market feels grumpy about the euro, EU, world economy, US economy, sovereign debt, etc, etc.

vinchainsaw 23 Sep 2011 , 1:12pm

A share that has dropped 90% can still drop another 100%...

jerryrc 23 Sep 2011 , 1:59pm

The whole banking business is now a total mystery to me, how they make money and how they value their 'assets', plus the whole investment rationale seems to be based on confidence and not much else.

My purchase of HBOS shares in 2007 being a case in point, in particular buying in to a 'discounted' rights issue at £2.50 per share when they were reporting net assets of £5 per share. Subsequently turned out they were lying and should have been reporting net assets of 0p per share.

Don't understand how fractional reserve banking can possibly work without some form of blow up every cycle.

I and thousands of investors were severly cheated by heads of banks and there is no reason to think the current crop of chiefs are any different.

diddyda 23 Sep 2011 , 2:11pm

Barclay's appear to have a policy of rewarding executives first and foremost with massive bonus's and letting the shareholders have the remaining scraps. Any company that treats its owners with such contempt will not feature in my share selection.

My solution to excessive bankers pay. If they exceed an acceptable limit withdraw the government support by way of the £80k investor guarantee. I think that tacit withdrawal of tax-payers support will soon have the fat-cats back in their boxes.

theRealGrinch 23 Sep 2011 , 2:16pm
CunningCliff 23 Sep 2011 , 3:48pm

vinchainsaw, "A share that has dropped 90% can still drop another 100%."

Tell me something I don't know. I've made this point time and again on TMF.

theRealGrinch, "avoid"

Sterling analysis, TRG! Care to elaborate? ;0)

Cliff

Dozey1 23 Sep 2011 , 4:48pm

I think diddyda has a very good point. The £80k government backed guarantee is effectively a publicly funded subsidy, insurance funded by us. Huge bonuses/salaries - cut the subsidy; lots of customers run. Brilliant.

vinchainsaw 23 Sep 2011 , 5:19pm

Apologies Cliff, I didnt mean to offend.

I just dont see a good enough risk/reward in banks at the moment.
There are so many things that could still go wrong.

I have HSBC and Barclays on my shopping list but I dont think financials will be leading out of this malaise so happy to wait and see how it plays out.

Each unto his own I suppose. Just not for me at this point.

BarneyCowshed 23 Sep 2011 , 5:28pm

Great idea from Diddyda.

He should send his post to George Osborne who needs a few good ideas.

ANuvver 23 Sep 2011 , 6:30pm

Cliff - no discussion of how the UK's planned segregation of investment and retail banking operations would affect shareholders?

Isn't it possible that holding BARC now will result in a split holding of Barcret (say) and Barcap at some point? And wouldn't the same prospect be even more likely in the event of a takeover - where presumably the investment arm would be a more likely target? Perhaps some Chinese, Sing or German megabank (possibly even someone like BOFA) will scoop it up at the right price and flog off the rump to someone like Branson. Who would then be able to play at Captain Mainwaring, as well as planes and trains.

I know it's foolhardy to buy a share on its attractiveness as an acquisition target, but surely one needs to factor such possibilities in.

UncleEbenezer 23 Sep 2011 , 9:29pm

The £80k support should be shifted from government to insurers, so banks would have to pay for it at whatever rate the market dictates.

Corollary: a safer bank pays less, a riskier one pays more. An incentive to behave.

Then drop the £80k fixed sum, and let each bank decide what level to offer. Thus a current account might offer a smaller sum, while an account targeted at businesses or solicitors doing conveyancing would insure a much higher amount. Limit the role of the law to one of insisting every account is open and transparent about what it offers and can't 'pull a fast one' by, say, changing its rules on the sly.

spyknife 23 Sep 2011 , 10:11pm

I bought into Barclays at 217p in July thinking I was getting a good deal.Now I feel sick, everytime I look at my ISA - and I feel trapped because if I sell I will take a huge hit.

Mrbeany 24 Sep 2011 , 12:52pm

Help! Am I stupid for thinking this?

Im 25 been playing with shares for a few months with about 5k,
I clear £1500 a month, and rent/bills is £300 my job is pretty secure.

I am thinking why not get a 15-20k loan at 6.5% for 3 years and stick is all on Barclays at 130-135 and hold out for as long as it takes to double my money hoping less then 2 years but even if I have to hang on for 10 years still seems to make sense.

Hopefully in a few years will have my deposit for a house. :)

What is the worse case scenario? Could I loss all my money? People seem to say that Barclays are strong and will not go bust, so am thinking If they do then a lot of others will. I which case I and everyone else will have more important thinks to worry about.

Would appreciate as much feedback as poss.


Thanks All

Samadd 24 Sep 2011 , 3:34pm

I am buying a few BARC, but drip feeding a few days apart.

I don't pretend to know banking any more than the man in the street. What I am working on is the assumption that bankers are cleverer than politicians. Whatever rules the politicians come up with the bankers will find a way round. Don't forget that they have the threat of relocating their registered office to another country with lighter regulation!

Are Barclays cheap at the moment? possibly. At the bottom of the crash they dropped to 50p but were only below their current price for a few weeks. I believe they will be back above £2 within the next 3 months.

However, not putting more than about 5% of portfolio on it!

keedy1 24 Sep 2011 , 4:27pm

@Mrbeany

Your initial question depends on where you sit. As a member of Joe Public, you'll probably be called stupid. If you sat on a trade floor in UBS, BarCap, Goldmans etc, you'd be doing your job.

When Lehmans and Bear Sterns went bust, they were leveraged by 30-35 to 1 (i.e. they had debt owed of $35 dollars to every $1 in assets held, be it cash, shares, bonds, whatever). So a £15K loan to £1.5K in savings is 10 to 1.

So you're not doing anything different to the investment bankers, but the questions is, are you going to get a big bonus or lose all your money?

Re Barclays -

There were probably quite a few people thinking in 2008, hmm, RBS shares look cheap at £4, £3, £2, £1, surely I'll just double my money if I hold out for 3 years?

They're currently sat at around 22p each.

If RBS hadn't been so keen to ramp up it's Investment Banking arm by pricing BarCap out of the bid for ABN AMRO, it's Barclays that would be owned by us / the Government, so don't think that their management team is any better than Fred Goodwin.

The Barclays share price is currently at levels last seen in October / November 2008 time when it traded around £135-140. Then it dropped. Hard. To 50-60p if memory serves me correctly.

If the shares tanked to those levels, how long would it take for you to earn the money you had lost? Would you be prepared to just take it on the chin and put off getting a deposit in 8 years instead of 3 years time?

Re your strategy -

If you clear around £1500 a month, you're grossing about £25K per annum. IF YOU INSIST ON DOING WHAT YOU'RE PROPOSING, you could get a credit card with a fairly substantial limit, a certain well known brand who also happen to have the same name as a train company gave me one with a £9K limit, no questions asked.

A balance transfer to a current account would give you a fee of 4%, loaded onto your card (so you'll need to leave room on the credit limit for that).

Each month, put as much salary into as high an earning savings account as you can, so that once the balance transfer period ends, you can pay off the debt on the card and the interest earnt will have eaten into the 4% debit charge.

Then pray like mad you've not tipped your capital (the money you borrowed in the first place) down the sink by buying shares.

Remember than the central banks are fast running out of options without resorting to quantative easing mark II (Bank of England) mark III (the US FED) and the ECB haven't yet had to work out how they'll recapatilise the French banks like we did with RBS, Lloyds, when Greece defaults on it's bond payments and gives the idea to the other PIIGS (Portugual, Ireland, Italy, Greece, Spain).

When is the next good news story coming out? And the next? And the next? When they do, the market will go back up.

But for now, by the time you've got the finances in place, I'll wager Barclays will be trading around £1.20-1.30 (my point being it's going to keep dropping for a while, not that its a better investment).

Mrbeany 24 Sep 2011 , 6:17pm

Thank you for that, Much appreciated

merl29 24 Sep 2011 , 8:30pm

jerryrc:

Yes the mistake i made with RBS was i thought it was cheap based on NAV.

When i did a post mortem of my mistake i realised i made an "obvious" mathmatical blunder.

To illustrate the difference between a bank and perhaps personal assets or business assets imagine the following:

You have £1million in assets and £300k in liabilities, what is nav? it is £700k right,ok so far ,so what would happen if your assets dropped by 10% ? not a whole lot you'd have nav of £600k still.

If you look at most people and business assets you see this sort of ratio.

Now imagine you have £1 Trillion in assets and £950 billion in liabilities, what is Nav? £50billion, right and if the stock price is £25billion it looks cheap.
But if the company lost 10% of its assets the Nav would be -50billion, a negative value.And bank balance sheets are more like that where small movements in capital make the NAV a worthless number.

stix55 25 Sep 2011 , 1:10pm

@keedy1.

Many thanks for your advice. I was about to do the same but may hold on now. Thanks

ANuvver 25 Sep 2011 , 8:56pm

Mrbeany: I applaud your bravery. As and when you go for something like this, best of luck for it and I'd love it to work out for you.

It's all very well to plan a leveraged investment like this, but quite another to watch what the rest of the world thinks eat your holding alive. Your strategy might prove right over time, but noone can know how long it takes to bring the return you have in mind.

Question one: "how bad would it have to get before you cut and run?" Question two: "would you have the discipline to pull out when your target is reached - or rather, how would you deal with the temptation to 'ride a good thing'?"

Would you get out when you're flat? Adjusted for projected inflation? Allowing for 20% drawdown? 40%? 80%? If it goes the other way, do you get out when you've got your deposit? Maybe you start thinking: "great, I've locked that in, now we'll go for more." "How about I go for more to bring down the mortgage payments?" "Hey, maybe even an extra bedroom..." It's all about how you rationalise things to yourself.

These are very difficult questions to answer until you're in the moment - in fact, there never is "the moment", and that's exactly the problem. But I'd suggest at least the honest admission that you don't know how you would react would be a great start.

goodlifer 26 Sep 2011 , 3:59pm

Thank you, Cliff, for this article, and for rousing me from my hoggish slumber.

I sold all my Barclays last December because they didn't pay a decent dividend, thinking I'd keep an eye on them till they looked like paying a dividend again.

Then, being me, I forgot all about them till I read your wake-up call.
On a ten year view their numbers make them a no-brainer to buy.

So I bought some this morning for a bit more than 139p.
But they seem to have gone up more than 2% - the first time ever a share I've bought's gone up on the day I bought it.

FWIW, I'm along term customer of Mr Barclay.
I seem to remember a spot of bother in about 1949, but that's just water under the bridge.
Since then, no complaints.
If my wife or children wanted to work for them I'd be very surprised, but can see no reason to be unhappy about it.
I seldom go into the actual branch, but when I do it seems full of contented customers and fiendly, busy staff

Nice now to think they're all working for me!

CunningCliff 26 Sep 2011 , 4:59pm

Thanks, goodlifer. BARC is now 155p, so that's a 16p gain on my 139p buy price. Here's wishing you even bigger gains!

Cliff

TopOnePercent 26 Sep 2011 , 5:46pm

Once again we seem to have a lot of people that don't understand the goverment guarantee.

If the government removed the fscs cover, banks & insurers would be able to offer it as a retail product.

The government doesn't offer you free motor insurance, nor free home insurance, and as a result you purchase these from insurance companies.

So, who really benefits from the government guarantee? Joe public, not the banks, and not the insurance companies. The level of ignorance around this issue constantly amazes me, but never more so when its writ large on a site frequented by supposedly by financially aware people.

Mrbeany 28 Sep 2011 , 10:35am

ANuvver

Thank you for the feedback I don’t know if you wanted answers for the questions, but I will anyway :)

I am thinking it’s going to crash probably the same or worse then 2008 when Barclays was 50p ish so I would probably stick 4k in at 80p and hopefully the rest at/if it hits 50p

I would then sell half at/if 150p and hang onto the rest hoping for 300p

Q1 I would not sell at a loss

Q2 Would you have the discipline to pull out when your target is reached? I think so, that’s pretty optimistic, and would be very happy if it happened.


I am aware I could lose it all, I would be gutted but not end of the world.

PeterEv 04 Oct 2011 , 9:14pm

"When Lehmans and Bear Sterns went bust, they were leveraged by 30-35 to 1 (i.e. they had debt owed of $35 dollars to every $1 in assets held, be it cash, shares, bonds, whatever). So a £15K loan to £1.5K in savings is 10 to 1."

To Keedy1,
This is wrong - the leverage of a bank is equal to the value of its total assets divided by the value of its equity capital, Assets/Equity.

If a bank had more in liabilities than assets it would be insolvent.

The point is, with assets of 35x more than equity it only takes a tiny fall in the value of assets to wipe out all the equity, ie high risk.

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